United States General Accounting Office GAO Report to Congressional Committees April 1997 DEFENSE RESTRUCTURING COSTS Information Pertaining to Five Business Combinations GAO/NSIAD-97-97 United States GAO General Accounting Office Washington, D.C. 20548 National Security and International Affairs Division B-276318 April 1, 1997 The Honorable Ted Stevens Chairman The Honorable Daniel K. Inouye Ranking Minority Member Subcommittee on Defense Committee on Appropriations United States Senate The Honorable C. W. Bill Young Chairman The Honorable John P. Murtha Ranking Minority Member Subcommittee on National Security Committee on Appropriations House of Representatives Section 8115 of the Fiscal Year 1997 Department of Defense (DOD) Appropriations Act1 requires us to examine restructuring costs2 of defense contractors involved in business combinations since 1993. In response, this report provides information on restructuring costs, including specific costs associated with workforce reductions and the services provided to workers affected by business combinations. It also identifies other funds used to help laid-off workers find new employment and describes why the effectiveness of restructuring costs used to assist laid-off workers in gaining new employment cannot be determined. In addition, the report discusses the extent of savings achieved from the business combinations relative to restructuring costs paid by DOD. To accomplish our work, we focused on five defense contractor business combinations: (1) Hughes Aircraft Company’s acquisition of General Dynamics Corporation’s Missile Operations, (2) the United Defense Limited Partnership (UDLP) between FMC Corporation’s Defense Systems Group and Harsco Corporation’s BMY Combat Systems Division, (3) Martin Marietta Corporation’s acquisition of General Electric Company’s aerospace and other business segments, (4) Northrop Corporation’s acquisitions of the Grumman Corporation and the Vought Aircraft Company to form the Northrop Grumman Corporation, and 1 Public Law 104-208, September 30, 1996. 2 Restructuring costs cover a wide range of expenses, such as personnel relocations, severance pay, early retirement incentives, equipment relocations, plant rearrangements, and facility closures. Page 1 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 (5) the merger of the Lockheed Corporation and the Martin Marietta Corporation to form the Lockheed Martin Corporation. The five business combinations had spent about $849 million at the time of Results in Brief our review for such restructuring activities as the disposal and relocation of facilities and equipment, consolidation of operations and systems, employee relocation, and workforce reductions. Of this amount, the business combinations spent about $89 million, or 10 percent, on workforce reductions, which consisted of severance pay, temporary continuation of health benefits, and outplacement services. About 15,000 workers left the companies as a result of the business combinations. Severance pay represented about 89 percent of total worker benefits. Expenditures for services to assist laid-off workers find reemployment totaled $4 million. In addition to those services provided from restructuring costs, we identified about $48 million in Department of Labor (DOL) grants made either directly to the contractors or to locations where workers were laid off as a result of the business combinations or normal downsizing. Moreover, there were at least 163 federally funded programs and funding streams that provided employment training assistance, of which 9 are targeted specifically for laid-off workers. During fiscal year 1996, funding for one of the nine programs totaled about $1.1 billion; however, no readily available means exist to determine the extent to which the majority of these funds, which are distributed at the state and local levels, were used to assist workers affected by the five business combinations. The business combinations were also providing some services that were not included in restructuring costs, but rather were paid as normal overhead costs. We were unable to determine the effectiveness of services for workers laid off specifically as a result of the business combinations because information critical to making such a determination—including reemployment rates, workers’ previous and current salaries, and satisfaction with their new jobs—are not maintained by the business combinations and are not readily available from other sources. In general, little empirical information is available on specific services that are the most useful and cost-effective. The Defense Contract Audit Agency (DCAA) estimated that, as of September 30, 1996, DOD had reimbursed these business combinations about $179 million toward its share of the $849 million the combinations Page 2 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 had incurred for restructuring activities. DCAA also estimated that DOD realized restructuring savings totaling $347 million from the business combinations during the same period. Therefore, for every $1.00 DOD has paid so far in restructuring costs, DOD has realized savings of $1.93. DOD officials believe that additional savings have been realized, but they did not document those savings. An industry representative also commented that these estimates cover only the period through September 1996, and therefore, do not reflect savings that may be realized in future periods. It should be noted, however, that the estimates also do not reflect any costs that may be incurred in subsequent periods. Finally, these estimates do not reflect DOL grant expenditures or any assistance from other federal programs or funding streams. Of the $179 million paid to the business combinations, DCAA determined that $18 million, or about 10 percent, represented additional costs to DOD as a result of the July 1993 decision to pay for restructuring costs on certain contracts transferred from one company to another after a business combination. The percentage of additional costs relative to the total amount paid may not be the same for future business combinations. Prior to July 1993, DOD had a long-standing practice of not permitting Background defense contractors to charge restructuring costs to flexibly priced3 contracts that were transferred4 from one contractor to another as a result of a business combination. The rationale for this practice was that DOD should not have to pay increased costs merely because one contractor is combined with another contractor. In July 1993, DOD changed its long-standing practice and uniformly began permitting defense contractors to charge restructuring costs to transferred flexibly priced contracts after a business combination, provided (1) the restructuring costs were allowable under the Federal Acquisition Regulation (FAR)5 and (2) a DOD contracting officer determined the business combination would result in overall reduced costs to DOD or preserve a critical defense capability. According to DOD officials, this 3 Flexibly priced contracts are a family of contracts under which the total amount paid to the contractor is dependent on the allowable costs the contractor incurs in performing the contract. 4 The transfer of contracts from one contractor to another involves a process called novation. The novation process requires a written agreement executed by the seller, buyer, and government, in which the government agrees to the transfer of its contracts. 5 The FAR contains guidelines for determining whether a particular restructuring cost is an allowable charge to a government contract. It also describes certain organization costs, such as legal and consulting fees applicable to business combinations, that cannot be charged to a government contract. Page 3 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 action was consistent with the flexibility provided by federal regulations. However, when asked, DOD officials stated that they were unaware of any instances where DOD had previously allowed restructuring costs to be charged to transferred contracts. As a result of its concerns over the payment of these costs, the Congress enacted section 818 of the National Defense Authorization Act for Fiscal Year 1995,6 which prohibited payment of restructuring costs to a defense contractor until a senior DOD official certified that projections of restructuring savings from the business combinations were based on audited cost data and should result in overall reduced costs to DOD. Section 818 also required the Secretary of Defense to report to the Congress on DOD’s experience with defense contractor business combinations, including whether savings associated with each restructuring actually exceed restructuring costs.7 The Congress modified authority for paying restructuring costs in section 8115 of the Department of Defense Appropriations Act for Fiscal Year 1997 by prohibiting payment of those costs for business combinations occurring after September 30, 1996, unless (1) restructuring savings for DOD were projected to exceed allowed costs by a factor of at least two to one or (2) the projected savings to DOD exceeded the costs allowed and the Secretary of Defense determined the business combination would result in the preservation of a critical capability, and (3) the DOD restructuring report for 1996 was submitted. As of December 31, 1996, the Under Secretary of Defense (Acquisition and Technology) had certified five business combinations for restructuring payments.8 Table 1 shows the certification dates for the business combinations in our review. We also included in our review the Hughes-General Dynamics business combination because DOD has included the combination in its restructuring reports to the Congress. However, the Hughes-General Dynamics combination did not go through the certification process because the combination occurred prior to enactment of the Defense Authorization Act for Fiscal Year 1995. 6 Public Law 103-337, October 5, 1994. 7 Section 818 required DOD to submit reports to the Congress on defense contractor restructuring activities for fiscal years 1995, 1996, and 1997. DOD transmitted the required reports for fiscal years 1995 and 1996 on June 18 and December 23, 1996, respectively. We subsequently refer to these reports as DOD restructuring reports. 8 We examined four of the five certified business combinations. We did not examine Martin Marietta Corporation’s acquisition of General Dynamics Corporation’s Space System Division because we were already examining two other business combinations involving Martin Marietta Corporation. Page 4 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 Table 1: Business Combination Certification Dates Business combination Date certified UDLP May 15, 1995 Martin Marietta-General Electric:a 5 projects September 19, 1995 3 projects February 14, 1996 5 projects September 17, 1996 Northrop Grumman February 14, 1996 Lockheed Martinb November 26, 1996 a One additional project is nearing certification. b Additional projects are expected to enter the certification process. The Defense Contract Management Command (DCMC) has lead responsibility for implementing DOD’s restructuring regulations. According to DCMC officials, they are tracking an additional 10 defense contractor business combinations that are currently in or expected to enter the various stages of the certification process. For the five business combinations we examined, certified restructuring Restructuring Costs costs totaled about $1.4 billion. At the time of our review, the companies had spent about $849 million (see table 2). To reflect the uncertainty in the cost estimates and reduce the need for recertification if the costs increased, ceilings ranging from 104 percent to 142 percent of certified costs were established for the restructuring projects. The contractors will not be permitted to charge DOD costs in excess of the portion of these ceilings applicable to DOD.9 9 Restructuring costs and cost ceilings are allocated to all of a contractor’s customers. DOD’s portion of restructuring costs and ceilings, therefore, depends on its share of the contractor’s total business base. Page 5 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 Table 2: Certified Costs, Cost Ceilings, and Incurred Cost, by Business Dollars in millions Combination Business combination Certified Ceiling Incurred a Hughes-General Dynamics $366.1 $370.0 $327.3 UDLP 36.4 38.0 38.6 Martin Marietta-General Electric 214.5 226.3 193.4 Northrop Grumman 70.4 100.1 75.1b Lockheed Martin 686.5 724.0 214.9 Total $1,373.9 $1,458.4c $849.3 a Certified costs for the Hughes-General Dynamics combination are estimated rather than certified because the business combination was not subject to the certification process. b Incurred costs for the Northrop Grumman combination include an estimate of cost-to-complete the restructuring. c DOD indicated that its projected share of the cost ceiling totaled $809.3 million. Restructuring after a business combination includes a wide range of activities, such as the disposal and modification of facilities, consolidation of operations and systems, relocation of workers and equipment, and workforce reductions. We grouped incurred restructuring costs for the five business combinations into broad categories (see table 3). Disposal and relocation of facilities and equipment was the largest category of total incurred restructuring costs. Table 3: Incurred Restructuring Costs by Category Dollars in millions Category Incurred Disposal and relocation of facilities and equipment $452.7 Relocation of employees 100.0 Benefits and services for laid-off workers 88.9 Consolidation of operations and systems 81.4 Restructuring planning and implementation 57.8 Other 68.5 Total $849.3 In total, the five companies projected that about 19,000 workers would Costs Associated With leave as a result of the business combinations and, at the time of our Workforce Reductions review, about 15,000 had left (see table 4). Page 6 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 Table 4: Projected and Actual Number of Workers Leaving Organizations as a Business combination Projected Actual Result of the Business Combination Hughes-General Dynamics 6,600 6,441 UDLP 483 500 Martin Marietta-General Electric 1,171 1,222 Northrop Grumman 450 450 Lockheed Martin 10,678 6,312a Total 19,382 14,925 a This number will increase as Lockheed Martin completes its planned restructuring projects. The wide variation in the number of job losses reflects differences in the nature of the restructurings. For instance, Northrop Grumman’s largest restructuring project involved closing the former Grumman corporate headquarters in Bethpage, New York, resulting in the loss of about 250 employees. By contrast, the Lockheed Martin restructuring involved closing facilities in New Jersey, Pennsylvania, and Texas, and consolidating various launch operations, radar and microwave operations, and corporate laboratories. Of the nearly $1.4 billion in projected restructuring costs, the five business combinations estimated they would spend about $175 million for benefits associated with workforce reductions. The costs included severance pay, temporary continuation of health benefits, and outplacement services. The estimated costs for worker benefits and services varied among the combinations, ranging from 8.6 percent to 23.9 percent of total certified restructuring costs as shown by table 5. Table 5: Estimated Costs for Benefits and Services for Laid-Off Workers by Dollars in millions Business Combination Total Estimated costs certified for benefits and Business combination costs services Percent Hughes-General Dynamics $366.1 $31.5 8.6 UDLP 36.4 8.7 23.9 Martin Marietta-General Electric 214.5 24.0 11.2 Northrop Grumman 70.4 9.3 13.2 Lockheed Martin 686.5 101.1 14.7 Total $1,373.9 $174.6 12.7 Of the $849.3 million already incurred for restructuring costs, the five contractors had expended $88.9 million, or about 10 percent, for benefits Page 7 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 and services for workers that left the corporations because of the business combinations (see table 6). However, Lockheed Martin has not completed its restructuring activities. Some of these activities are projected to involve additional workforce reductions, which will lead to additional severance and outplacement costs. Table 6: Incurred Costs for Worker Benefits and Services by Business Dollars in millions Combination Total Costs incurred incurred for benefits and Business combination costs services Percent Hughes-General Dynamics $327.3 $31.3 9.6 UDLP 38.6 5.3 13.7 Martin Marietta-General Electric 193.4 22.5 11.6 Northrop Grumman 75.1 8.8 11.7 Lockheed Martin 214.9 21.0 9.8 Total $849.3 $88.9 10.5 Severance pay was by far the largest worker benefit and comprised about 88 percent and 89 percent of the estimated and incurred costs for worker benefits and services, respectively (see table 7). Each of the five business combinations provided severance pay to workers, and four provided for the temporary continuation of health benefits and other services to assist laid-off workers find new employment. Table 7: Costs Associated With Worker Benefits and Services by Category Dollars in millions Benefit or service Estimated Incurred Severance pay $153.3 $79.5 Continuation of health benefits 13.4 5.6 Reemployment assistance 7.8 4.0 a Total $174.5 $88.9 a Totals may not add due to rounding. Severance pay varied with such factors as whether the workers were salaried or hourly employees and the length of time they had been with the corporations. Additional differences were the result of the individual contractor’s worker benefit packages before the business combinations. For example, in the Hughes-General Dynamics combination, former Hughes workers received severance pay, but former General Dynamics workers did not. Also, neither the Northrop nor Vought Corporations had Page 8 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 severance benefits for its workers, but the Grumman Corporation did. After the business combination, therefore, former Northrop and Vought workers received no severance benefits, but former Grumman workers received the severance benefits they would have received had there been no business combination. The four business combinations that provided services to help workers Services Provided to laid off find new employment estimated they would spend $7.8 million for Assist Laid-Off such services. At the time of our review, the four companies had expended Workers Find New $4 million for these services (see table 8). The cost of these services represents less than 1 percent of both the total certified and incurred Employment restructuring costs. Table 8: Costs for Services to Assist Laid-Off Workers Find New Dollars in millions Employment by Business Combination Business combination Estimated Incurred Hughes-General Dynamics $1.0 $1.0 UDLP 0.7 0.2 Martin Marietta-General Electric 1.4 1.6 Northrop Grumman 0 0 Lockheed Martin 4.7 1.2 Total $7.8 $4.0 The services provided to help laid-off workers find new employment fell into two categories—educational and outplacement services (see table 9). In the Martin Marietta-General Electric business combination, retraining services were provided in accordance with the General Electric layoff benefits plan. Under plant closing provisions, all former General Electric employees were eligible for up to $5,000 tuition reimbursement for any licensed or accredited occupational or educational courses up to 3 years from the date of layoff. There was a requirement, however, that an employee start at least one course within the first year after layoff. Former Hughes employees were also provided educational benefits up to $5,000 for attendance at an accredited college or university and the successful completion of classes that started within 1 year of the time the worker was laid off. Page 9 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 Table 9: Cost of Services to Help Workers Find New Employment by Dollars in millions Category Benefit or service Estimated Incurred Retraining and educational assistance $2.0 $1.7 Outplacement services 5.8 2.3 Total $7.8 $4.0 In addition to providing educational assistance, Martin Marietta also provided various outplacement services. As a result of a plant closing at Bridgeport, New Jersey, for example, Martin Marietta operated an on-site employment transition center for a 9-month period in 1994. Designed to serve 392 employees affected by the plant closing, the center provided career transition workshops, resume development, telephone and interviewing skill practice, salary negotiations, career counseling, job support groups, and job fairs. Martin Marietta incurred about $326,000 in restructuring costs to operate the center. Martin Marietta established a similar center to assist workers affected by the closing of a facility in Conklin, New York. Restructuring costs for this center amounted to $177,000, which included the salary costs for the center’s director and counselor, equipment rentals, and telephone expenses. In addition to services being paid through restructuring costs, services Other Funds Used to were also funded by DOL grants and through normal overhead charges at Assist Laid-Off the business combinations. Services funded by DOL were available to Workers Find New laid-off workers regardless of whether they were terminated as a result of a defense contractor business combination or normal downsizing, and Employment some services were made available to workers from other companies. However, neither DOL, the business combinations, nor the grant recipients maintained records showing how many workers who used these services were terminated as a result of the combination. Services Funded by DOL Many federally funded programs exist to assist laid-off workers find new Grants employment. We reported, for example, in February 1995 that at least 163 federally funded programs and funding streams existed that provided employment training assistance, of which 9 are targeted specifically for laid-off workers.10 Among the most significant programs are those authorized by the Economic Dislocation and Worker Adjustment 10 Multiple Employment Training Programs: Major Overhaul Needed to Create a More Efficient, Customer-Driven System (GAO/T-HEHS-95-70, Feb. 6, 1995) and Multiple Employment Training Programs: Information Crosswalk on 163 Employment Training Programs (GAO/HEHS-95-85FS, Feb. 14, 1995). Page 10 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 Assistance (EDWAA) Act. In total, the Congress appropriated about $1.1 billion in fiscal year 1996 EDWAA grants to help dislocated workers. Funds provided under EDWAA are allocated by a formula in which 80 percent of the appropriated funds are provided directly to the states, with the remaining 20 percent reserved for the Secretary’s discretion. The discretionary funds may be awarded to projects for workers dislocated due to mass layoffs, plant closures, disasters, and federal government actions. In addition, the Congress appropriated $150 million in fiscal year 1991 for Defense Conversion Adjustment Program (DCAP) grants, which are available to address the training and employment needs of workers dislocated by defense downsizing, including consolidation actions subsequent to cutbacks in defense budgets. DCAP grants can be awarded to states or directly to defense contractors. The Congress also appropriated $75 million in fiscal year 1993 for Defense Diversification Program (DDP) grants to provide training, adjustment assistance, and employment services to members of the armed forces and DOD and defense contractor employees who were either involuntarily separated or laid off as a result of reductions in defense spending. DOL officials told us they do not collect information on whether EDWAA, DCAP, or DDP funds were used to assist workers specifically laid off as a result of defense contractor business combinations. These officials indicated that some grant requests contain information that may make it possible to relate the layoffs to specific factors such as plant closings. However, they noted that service providers are not required to maintain information or report on the reasons why the workers were laid off. These officials acknowledged that because defense contractor business combinations can result from decreases in defense spending, some of the funds may have been used to assist workers dislocated as a result of these business combinations. We identified about $48 million in discretionary, DCAP, or DDP grants made either directly to defense contractors involved in the business combinations or to locations affected by those combinations. DOL awarded Hughes two grants totaling $16 million to assist workers affected by downsizing in southern California, and another two grants totaling $1.2 million to Martin Marietta to assist workers in central Florida. Another 10 grants—totaling about $31.1 million—were awarded to 8 states that were affected by restructuring activities of the business combinations. Three of these grants, totaling $21 million, were targeted to assist a group Page 11 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 of 22 defense and defense-related companies or facilities in southern California, including Northrop Grumman. A New York grant, totaling about $5.3 million, was targeted to assist former Grumman employees. Various outplacement services were provided under these grants, including vocational and career guidance, job search assistance, and basic skills training. Although the amount of grant funds are significant for the five business combinations we examined, DOD’s guidance for preparation of the annual reports to the Congress on defense contractor restructuring activities does not require reporting any information on DOL grants. Because these grants are related to defense contractor restructuring activities, including grant information in the reports—especially on those grants made directly to contractors—would give the Congress useful information on funding available to assist workers affected by defense contractor business combinations. Services Funded Through Several of the business combinations operated outplacement facilities Contractor Overhead where workers could obtain assistance in finding new employment and charged the operational costs to overhead expenses rather than restructuring costs. For example, UDLP operated a center during the period 1994 through 1996 and all terminated employees—regardless of whether they were laid off as a result of the business combination or normal downsizing—could obtain assistance at the center in writing resumes, arranging for job interviews, reviewing job listings, and other related outplacement services. UDLP expended $205,000 in operating this center during the 3-year period and paid an additional $109,000 to a consulting firm to assist middle- and senior-level management officials find new employment. UDLP charged these costs to overhead rather than restructuring costs. Similarly, Northrop Grumman and Lockheed Martin also provided counseling and/or outplacement assistance to help workers find new employment and charged the costs to overhead expenses rather than restructuring costs. Page 12 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 We were unable to determine the effectiveness of the services provided to Effectiveness of help laid-off workers find new employment. Like most organizations, the Services Provided to five business combinations we examined did not have a comprehensive Help Terminated system in place to evaluate outplacement effectiveness. Officials cited various difficulties that prevent them from implementing such a system. Workers Find New Similarly, information needed to determine the effectiveness of these Employment Could services is not readily available from DOL. Not Be Determined Two basic elements are required in a comprehensive system for assessing the effectiveness of outplacement services: (1) criteria against which to make the assessment and (2) a tracking system to collect relevant performance information. Our work and work by DOL shows that most organizations do not evaluate outplacement services in terms of such criteria as whether those who received services are reemployed faster, received higher salaries, or were more satisfied with the jobs they found than a control group of those individuals who did not receive such assistance.11 Participants at a recent workshop conducted by the Office of the Deputy Assistant Secretary of Defense (Civilian Personnel Policy) and the National Academy of Sciences concluded that no empirical work has been able to identify the aspects of outplacement programs that are the most cost-effective and useful in terms of these criteria.12 The business combinations we examined did not have a comprehensive system in place to track the effectiveness of services they provided to laid-off workers. Officials from Lockheed Martin, for example, told us that comprehensive tracking is difficult, especially in cases of a plant closure as there would then be no company representative on location to do the tracking. In addition, some laid-off workers do not want further contact with their former employer, making tracking difficult. Officials noted, moreover, that former employees have no obligation or incentive to report information regarding their subsequent employment status or salary information. Similarly, information needed to determine the effectiveness of services provided to workers laid off as a result of the business combinations is not 11 Multiple Employment Training Programs: Most Federal Agencies Do Not Know If Their Programs Are Working Effectively (GAO/HEHS-94-88, Mar. 2, 1994); Multiple Employment Training Programs: Major Overhaul Needed to Reduce Costs, Streamline the Bureaucracy, and Improve Results (GAO/T-HEHS-95-53, Jan. 10, 1995); Workforce Reductions: Downsizing Strategies Used in Selected Organizations (GAO/GGD-95-54, Mar. 13, 1995); Employment Training: Successful Projects Share Common Strategies (GAO/HEHS-96-108, May 7, 1996); and A Guide to Well-Developed Services for Dislocated Workers, U.S. Department of Labor, Employment and Training Administration. 12 Issues in Civilian Outplacement Strategies: Proceedings of a Workshop, National Academy Press, Washington, D.C., 1996. Page 13 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 readily available from DOL. DOL does not collect certain critical information, such as participant satisfaction with the position obtained or the relative success of control groups who do not participate in the programs. DOL officials stated that they did maintain information that reflects various measures of the effectiveness of DOL-funded programs at the aggregate level, such as whether program participants obtained a new position and participants’ average wages before and after receiving the services. DOL officials expressed concern, however, about using their data, noting that the service providers do not always submit accurate or complete information. Finally, these officials noted that they could not provide information pertaining specifically to any of the business combinations in our review. Defense contractors are required to maintain accounting records showing Comparing the actual amount and nature of costs charged to government contracts. Restructuring Costs These costs are generally billed to government contracts during the same and Estimated period they are incurred. As discussed earlier, however, the section 818 prohibition against payment of restructuring costs until certification of net Savings savings creates a requirement for the contractor to segregate restructuring costs in its accounting records and to exclude these costs from any billings, final contract price settlements, and overhead settlements until the certification is made. After the certification, the contractor is then permitted to begin charging restructuring costs to DOD contracts. The contractor generally recovers restructuring costs over a 5-year period but the recoupment period may be shorter, depending on the terms of the advance agreement negotiated between DOD and the contractor. Restructuring savings, on the other hand, are not recorded in a contractor’s accounting records. Therefore, neither the amount nor the nature of the savings can be determined by reviewing the accounting records. Consequently, savings have to be estimated. For example, Northrop Grumman estimated 5-year savings from closing the Grumman corporate headquarters of about $215 million, of which about $100 million represents the labor and fringe costs that would be avoided over the 5-year period by laying off approximately 250 workers. These savings are therefore an estimate of a cost avoidance over the 5 years—the costs of the additional people that would have been needed had the headquarters not been closed. Savings from restructuring activities we examined were generally in the form of such future cost avoidances. Page 14 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 The initial estimate of restructuring savings is simple in concept because it makes the critical assumption that everything else, except for the restructuring, is the same after a business combination as before. Because things are never the same, it is difficult to precisely identify actual savings several years after the initial estimate is prepared. The December 1996 DOD restructuring report acknowledges this problem. It points out that restructuring is not the only factor that has an impact on actual costs. Other factors affecting costs include changes in the rate of inflation, fluctuations in the business base, and subsequent reorganizations. At the request of DCMC, DCAA did a study of the estimated amount of restructuring costs paid and the estimated amount of savings realized as of September 30, 1996, for the business combinations for which DOD had allowed restructuring costs. DCAA estimated that DOD had paid $179.2 million in restructuring costs and realized estimated restructuring savings of $346.7 million as of September 30, 1996, for a net savings of $167.5 million (see table 10). Table 10: Estimates of Paid Restructuring Costs and Experienced Dollars in millions Savings by Business Combination Experienced Business combinationa Paid costs savings Net savings b Hughes-General Dynamics $124.3 $147.9 $23.6 UDLP 9.9 22.9 13.0 c Martin Marietta-General Electric 36.7 108.2 71.5 Northrop Grummand 8.3 67.7 59.4 Total $179.2 $346.7 $167.5 a Lockheed Martin was not included in the DCAA study because it was certified after September 30, 1996. b Represents savings on only eight contracts. c Represents restructuring costs and savings from the first eight certified restructuring projects. DCAA did not project costs and savings for the five projects certified on September 17, 1996, because actual experience through September 30, 1996, would have been minimal. d Estimated savings are based on two of the six projects certified. These two projects accounted for 90 percent of total projected savings. Measured another way, the figures shown in table 10 indicate that DOD has realized $1.93 in savings for each $1.00 of restructuring cost paid. DOD officials acknowledged that while their estimates reflect $1.93 in savings for each dollar reimbursed, they believed additional savings were being realized. They explained that DOD had based its estimate of savings for the Page 15 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 Hughes-General Dynamics business combination on only eight contracts that demonstrated savings in excess of costs. They noted that documenting higher savings was not considered a prudent use of resources. An industry representative also commented that the estimates covered only the period through September 1996 and therefore do not consider savings that may be realized in future periods. It should be noted that the estimates in table 10 also do not reflect any costs that may be incurred in subsequent periods. Finally, the estimates do not reflect DOL grant expenditures or any assistance from the other federal programs or funding streams. Of the $179.2 million DOD has paid to these four business combinations for restructuring costs, DCAA determined that $18 million, or about 10 percent, was charged to novated flexibly priced contracts. The $18 million, therefore, represents the amount of additional costs to DOD as a result of its decision in July 1993 to allow contractors to charge restructuring costs to novated flexibly priced contracts. It should be noted that the 10 percent in additional costs for these four business combinations may not be representative of the percentage for future business combinations because of differences in factors that determine the percentage, including the mix of flexibly priced and firm fixed-price contracts and the period of time required for certification. Because direct federal grant funds can be substantial, as in the Recommendation Hughes-General Dynamics and Martin Marietta-General Electric business combinations, we recommend that the Secretary of Defense obtain information about significant federal direct grants to defense contractors involved in business combinations and include this information in the DOD annual restructuring reports to the Congress. Such information could include the grants’ dollar values, purposes, and periods of performance. In commenting on a draft of this report, DOD generally concurred. DOD Agency Comments suggested several technical clarifications, and we have incorporated them and Our Evaluation in the text where appropriate. DOD’s comments are presented in its entirety in appendix I. DOL did not indicate any overall assessment of the report, but did provide several technical clarifications, which we have incorporated in the text where appropriate. DOL’s comments are presented in their entirety in appendix II. Page 16 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 The Aerospace Industries Association (AIA) provided comments on a draft of this report on behalf of the business combinations we reviewed. AIA noted that, on balance, the report was objective. AIA offered several technical changes to clarify the information provided, which we have incorporated in the text where appropriate. AIA’s comments are provided in their entirety in appendix III. To respond to the requirements of section 8115 of Public Law 104-208, we Scope and selected the three business combinations for which the Under Secretary of Methodology Defense (Acquisition and Technology) had issued a letter of certification as of September 30, 1996. Two additional business combinations were certified by the Under Secretary of Defense (Acquisition and Technology) on November 26, 1996, involving the Lockheed-Martin Marietta business combination and Martin Marietta’s May 1994 acquisition of General Dynamics Corporation’s Space System Division. We included the Lockheed-Martin Marietta combination because of the large amount of restructuring costs and savings involved in this combination, but excluded the Martin Marietta-General Dynamics combination because we were already examining two other combinations involving Martin Marietta. While the Hughes-General Dynamics business combination did not have to undergo the certification process, we included it in our review because DOD has included the combination in its restructuring reports to the Congress. To determine the amount and nature of restructuring costs, we obtained information from each of the business combinations and DOD showing the amount and nature of certified and incurred restructuring costs at the time of our review. We analyzed the information provided by the business combinations along with DCAA audit reports and pertinent DOD and DCMC records to determine the amount and nature of restructuring costs incurred for workforce reductions and to identify the cost and nature of services provided to assist laid-off workers find reemployment. However, we did not independently verify the information provided. We also met with DOL officials and obtained information on federal grants made to assist displaced defense contractor workers find new employment. We reviewed files for grants awarded under the DOL Secretary’s discretion or under the DCAP and DDP programs that DOL officials identified as being targeted to locations in which restructuring activities were occurring. To address the issue concerning the effectiveness of outplacement services in assisting displaced workers find Page 17 GAO/NSIAD-97-97 Defense Restructuring Costs B-276318 reemployment, we obtained and reviewed information provided from DOL, DOD, academia, and each of the business combinations. In assessing restructuring savings realized from the business combinations relative to the restructuring cost paid by DOD, we examined the methodology DCAA used to estimate the amount of restructuring costs paid by DOD and the amount of estimated savings. We generally found their approach and methodology to be reasonable and relied on their work to determine the estimated amount of savings realized and costs paid by DOD as of September 30, 1996. We discussed various aspects of the restructuring costs and savings with officials from each of the business combinations, DOD, DCMC, DCAA, the DOD Inspector General, and DOL. Additionally, we provided summaries of our work to the contractors’ representatives to review for accuracy. We performed our review between October 1996 and March 1997 in accordance with generally accepted government auditing standards. We are sending copies of this report to the Secretaries of Defense and Labor; the Commander, DCMC; the Director, DCAA; the Director, Office of Management and Budget; and interested congressional committees. Copies will also be made available to others upon request. Please contact me at (202) 512-4841 if you or your staff have any questions concerning this report. The major contributors to this report are listed in appendix IV. David E. Cooper Associate Director Defense Acquisitions Issues Page 18 GAO/NSIAD-97-97 Defense Restructuring Costs Page 19 GAO/NSIAD-97-97 Defense Restructuring Costs Contents Letter 1 Appendix I 22 Comments From the Department of Defense Appendix II 25 Comments From the Department of Labor Appendix III 28 Comments From the Aerospace Industries Association Appendix IV 31 Major Contributors to This Report Tables Table 1: Business Combination Certification Dates 5 Table 2: Certified Costs, Cost Ceilings, and Incurred Cost, by 6 Business Combination Table 3: Incurred Restructuring Costs by Category 6 Table 4: Projected and Actual Number of Workers Leaving 7 Organizations as a Result of the Business Combination Table 5: Estimated Costs for Benefits and Services for Laid-Off 7 Workers by Business Combination Table 6: Incurred Costs for Worker Benefits and Services by 8 Business Combination Table 7: Costs Associated With Worker Benefits and Services by 8 Category Table 8: Costs for Services to Assist Laid-Off Workers Find New 9 Employment by Business Combination Table 9: Cost of Services to Help Workers Find New Employment 10 by Category Page 20 GAO/NSIAD-97-97 Defense Restructuring Costs Contents Table 10: Estimates of Paid Restructuring Costs and Experienced 15 Savings by Business Combination Abbreviations AIA Aerospace Industries Association DCAA Defense Contract Audit Agency DCAP Defense Conversion Adjustment Program DCMC Defense Contract Management Command DDP Defense Diversification Program DOL Department of Labor DOD Department of Defense EDWAA Economic Dislocation and Worker Adjustment Assistance FAR Federal Acquisition Regulation UDLP United Defense Limited Partnership Page 21 GAO/NSIAD-97-97 Defense Restructuring Costs Appendix I Comments From the Department of Defense Page 22 GAO/NSIAD-97-97 Defense Restructuring Costs Appendix I Comments From the Department of Defense Now on p. 3. Now on pp. 3 and 4. Page 23 GAO/NSIAD-97-97 Defense Restructuring Costs Appendix I Comments From the Department of Defense Now on p. 5. Now on p. 16. Page 24 GAO/NSIAD-97-97 Defense Restructuring Costs Appendix II Comments From the Department of Labor Page 25 GAO/NSIAD-97-97 Defense Restructuring Costs Appendix II Comments From the Department of Labor Now on p. 2. Now on pp. 2, 13, and 14. Now on p. 11. Now on p. 11. Page 26 GAO/NSIAD-97-97 Defense Restructuring Costs Appendix II Comments From the Department of Labor Page 27 GAO/NSIAD-97-97 Defense Restructuring Costs Appendix III Comments From the Aerospace Industries Association Now on p. 3. Now on pp. 3-4. Page 28 GAO/NSIAD-97-97 Defense Restructuring Costs Appendix III Comments From the Aerospace Industries Association Now on p. 3. Now on p. 3. Now on p. 4. Now on p. 5. Now on pp. 3 and 16. Page 29 GAO/NSIAD-97-97 Defense Restructuring Costs Appendix III Comments From the Aerospace Industries Association Page 30 GAO/NSIAD-97-97 Defense Restructuring Costs Appendix IV Major Contributors to This Report John K. Harper National Security and Timothy J. DiNapoli International Affairs Paula J. Haurilesko Division, Washington, John D. Heere Rosa M. Johnson D.C. George C. Burdette Atlanta Field Office Erin B. Baker Ambrose A. McGraw Los Angeles Field Kenneth H. Roberts Office Thaddeus S. Rytel, Jr. Ruth A. Hijazi San Francisco Field Donald Y. Yamada Office (707219) Page 31 GAO/NSIAD-97-97 Defense Restructuring Costs Ordering Information The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. 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Defense Restructuring Costs: Information Pertaining to Five Business Combinations
Published by the Government Accountability Office on 1997-04-01.
Below is a raw (and likely hideous) rendition of the original report. (PDF)